An immediate annuity is an insurance product that gives the buyer a guaranteed stream of income in exchange for a lump sum of cash. Immediate annuities have several advantages, such as long-term stability, tax-deferred income, and monthly income payments for the rest of your life.

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Immediate annuities

An immediate annuity is a contract under which a company agrees to give you a fixed amount of money per month, starting immediately. Generally, immediate annuities are intended to create lifelong income streams, but there are some that only pay for a set period.

An immediate annuity is similar in structure to a pension plan: You give a company a lump sum of cash in exchange for guaranteed income.

This type of annuity is most appropriate for people who are already retired and are looking for peace of mind regarding their retirement income. Pre-retirees and other people who don't need the money right away may want to consider a deferred annuity, which delays payment by a number of years but makes higher guaranteed monthly payments.

Advantages and disadvantages

Before you can decide whether an immediate annuity is a good choice for you, it's important to consider the advantages and disadvantages of this type of investment.

Here are some of the advantages of immediate annuities:

  • You start receiving income right away.
  • You cannot outlive your retirement savings.
  • Stable, locked-in income stream. Annuity funds are guaranteed by the assets of the company you buy them from.
  • Simplicity: You don't have to take any further steps once you've purchased your annuity, and you don't need to monitor your investment.
  • Tax advantages: An immediate annuity can allow you to defer taxes until later in retirement. If you use a tax-deferred account to fund an annuity, then you'll only pay taxes as you receive the income, rather than all at once.
  • The payments can be higher than the returns on other safe investments like certificates of deposit. However, keep in mind that some of your annuity payments consists of return of principle. Your total returns with an annuity are likely to be rather small compared with "riskier" investments.

However, consider the drawbacks:

  • The benefit expires when you die. As you'll read shortly, you can buy annuities that are guaranteed for a certain time period, but these come with lower payments.
  • If you need access to your money (like in an emergency), you won't have access to the principal you paid.
  • Loss of purchasing power over time (unless you buy an inflation-protected annuity) will result in a lower initial monthly income.
  • The fees associated with buying an annuity can be high.

Options you can choose with immediate annuities

While the basic concept of an immediate annuity is simple, there are several options you can choose from, including but not necessarily limited to:

  • Life: Pays out a fixed monthly amount for the rest of your life. If you die, payments stop.
  • Life with cash refund: If you die before the entire principal amount has been paid back, your beneficiaries will receive a check for the difference. This feature will generally come with lower monthly payments.
  • Period certain: Instead of paying income for the rest of your life, a period-certain annuity makes payments for a specified amount of time, such as 10 or 20 years.
  • Life and period certain: This allows you to You'll receive monthly payments for as long as you live, but if you die within the specified period, your beneficiaries will continue to receive payments until the period runs out. For example, if you have a "Life & 10 Years Certain" annuity and die after six years of collecting payments, your beneficiaries will receive your monthly payment for four more years.
  • Joint annuities: The conditions apply to two people, not just one. These are popular among married couples, and all types of immediate annuities can be offered as joint annuities. For example, a joint life annuity will continue to make payments as long as at least one of the two beneficiaries is alive.
  • Variable immediate annuity: Invests some of your principal in mutual fund portfolios, and your payments can increase with your investment performance.
  • Inflation-protected annuities: Some companies offer a rider that provides an annual cost-of-living adjustment (COLA) on immediate annuities in order to maintain the buying power of the annuity's monthly income.

Is an immediate annuity right for you?

If the advantages outweigh the disadvantages for your personal situation, then an immediate annuity can be an excellent tool to create worry-free retirement income. An immediate annuity is a risk-management tool, and it can be a useful part of a retirement plan, especially when combined with other types of retirement assets.

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